Morning Brief – It’s okay, Truss me.

Charles Porter
Tue 27 Feb 2024

It’s okay, Truss me.

On Wednesday next week Chancellor Jeremy Hunt will deliver the UK Spring budget. We are in the final straight with significant speculation over the shape of the budget taking place. The Treasury and OBR will have scrutinised the latest forecasts and the final budget will soon be cast in stone. Despite the policy action being soon to be (if not already) fixed, market conditions that will dictate how such policy plays out in the economy, will never be fixed. Interest rate expectations have risen globally as investors scale back the extent of expected interest rate cuts. In the UK this has taken place to leave interest rate expectations approximately 1% higher throughout 2025 versus those priced in at the start of this year. 

Higher interest rate expectations drive borrowing costs higher. That raises the cost of servicing existing and new government debt that is needed to fund the tax cuts and spending pledges the Chancellor may be eyeing up next Wednesday. Whilst the Chancellor still has significant headroom to afford tax cuts, it is shrinking. What’s perhaps more concerning is that should the market react negatively to the budget and perceive a risk to Gilts from the cuts, we could end up in a destructive spiral scenario reeking of Kwarteng’s September ‘22 mini budget. So, are we headed for a tax break, and will we experience Armageddon if we get one?

The likely answer is yes, we are expecting tax cuts but Armageddon is unlikely. It will depend on how the Chancellor funds tax cuts – will he use the fiscal headroom that former budgets have provided or will future spending constraints be used to fund present tax cuts? The latter could cause more headaches and risk than the former triggering concern amongst investors. The main reason a market meltdown is unlikely is that the market conditions in which the Chancellor will deliver the budget are 10x more favourable than those Liz Truss’ government faced. Implied volatility in options markets shows a stable and confident market. Options markets currently price an expected range of just 57 USD pips within cable versus a standard 48 USD pips on non-budget days. This calmer and deeper market will allow FX and wider financial markets to endure far more fiscal stress than they could at the time of the mini-budget.

Discussion and Analysis by Charles Porter

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